IBR vs. PAYE: Which Income-Driven Plan Is Better for Your Wallet?

IBR or Pay As You Earn

If you’re struggling to make your student loan payments, you may need to switch up your repayment plan. An income-driven repayment (IDR) plan could be the solution you need to save your wallet.

As the name suggests, IDR plans adjust your student loan payments based on your income. This helps make it easier for you to keep up with payments.

Two popular IDR plans are Income-Based Repayment (IBR) and Pay As You Earn (PAYE). Both plans have a lot in common, but they also have some key differences.

Here’s a look at how these two repayment plans differ, and whether you should use IBR or Pay As You Earn.

What you need to know about IBR

Income-Based Repayment adjusts your student loan payments based on your income. If you borrowed loans after July 1, 2014, your monthly loan payments will be set at 10 percent of your discretionary income. If you borrowed loans before that date, you’ll pay 15 percent.

To get on IBR, you need to show that you have a high debt-to-income ratio. Your current payments on the standard 10-year plan must exceed 10 or 15 percent of your discretionary income. If IBR will help lower your payments, there’s a good chance you’ll qualify for it.

IBR also extends your repayment period. On IBR, you’ll switch to a 20- or 25-year repayment term. If you still owe money on your student loans after the repayment period ends, the government will forgive the remaining balance. You will no longer have to pay the loan, but you may have to pay income taxes on the forgiven balance.

Most federal loans are eligible for IBR. Loans that don’t qualify are certain loans made to parents and private loans.

How the PAYE plan works

Like IBR, Pay As You Earn lowers your monthly student loan payments based on your income. It caps payments at 10 percent of your discretionary income, and you will never have to pay more than you would on the Standard Repayment Plan.

PAYE extends your repayment period to 20 years and forgives any remaining balance after that. Although PAYE offers a shorter repayment period than IBR for new borrowers, it is harder to qualify for the plan.

To qualify for PAYE, you must be a new borrower as of Oct. 1, 2007. You must also have taken out a Direct Loan on or after Oct. 1, 2011. If you have a balance on a Direct Loan or FFEL Program loan that originated before October 2007, you won’t qualify for the PAYE Plan.

PAYE covers most of the same federal loans as IBR, and it similarly excludes certain loans made to parents, such as Direct PLUS and FFEL PLUS Loans, as well as private loans.

Unlike IBR, however, PAYE requires you to consolidate certain loans before switching to the plan. If you’re interested in PAYE, you may have to take the additional step of taking out a Direct Consolidation Loan before you can qualify.

IBR vs. Pay As You Earn: How are they different?

1. PAYE can lower your student loan bills more than IBR

If you have student loans from before July 1, 2014, PAYE can lower your monthly payments. That’s because PAYE caps your student loan bill at 10 percent of your income.

Under IBR, payments for your older loans are set at 15 percent of your income. However, if your student loans are newer, IBR will cap payments at 10 percent.

2. PAYE offers loan forgiveness 5 years earlier than IBR

Both plans offer loan forgiveness if you still have a student loan balance at the end of your repayment term. For newer borrowers, PAYE offers loan forgiveness after 20 years of payments — IBR offers forgiveness after 25 years.

If you can qualify for PAYE, you could get out of student debt five years earlier. However, remember that a forgiven loan is treated as taxable income. If you have a bigger balance after 20 years than you would after 25, you may get hit with a bigger tax bill.

3. Both plans have interest benefits, but PAYE has a better one

One nice perk of both IBR and PAYE is their interest benefit for subsidized loans.

If the interest that accrues on your subsidized loans each month is greater than your payments under IBR or PAYE, the government will pay the difference. This benefit lasts for up to three years from the day you begin repaying under IBR or Pay As You Earn.

One key difference between these two repayment plans comes down to the amount of interest that may be capitalized.

Under PAYE, if you no longer qualify to make income-driven payments, the unpaid interest that may be capitalized is limited to 10 percent of the loan balance you had when you entered the PAYE Plan. On the other hand, IBR does not limit the amount of interest that may be capitalized.

4. PAYE is harder to qualify for than IBR

While PAYE may lower your student loan bills and get you out of debt faster than IBR, it can be harder to qualify.

To get on the PAYE Plan, you need to be a new borrower as of Oct. 1, 2007, and your Direct Loans must have disbursed after Oct. 1, 2011. IBR has no “new borrower” qualification requirement.

5. IBR doesn’t require you to consolidate most loans

For some student loan borrowers, IBR may be easier to apply for than PAYE. Unless consolidated, the following loans do not qualify for PAYE:

  • Subsidized Federal Stafford Loans from the FFEL Program
  • Unsubsidized Federal Stafford Loans from the FFEL Program
  • FFEL PLUS loans made to grad or professional students
  • FFEL Consolidation Loans that didn’t repay PLUS Loans made to parents

The above loans qualify for IBR without consolidation. To apply for PAYE, you’ll first need to get a Direct Consolidation Loan for the above loans.

That said, both plans ask you to consolidate Federal Perkins Loans. Please note that the Perkins Loan program expired in September, 2017. However, if you have Perkins Loans, they are still eligible for IBR or PAYE as long as you consolidate them first.

Should you choose IBR or Pay As You Earn?

In some respects, the Pay As You Earn Plan comes out as the clear winner against IBR. It lowers your monthly payments to just 10 percent of your discretionary income and offers loan forgiveness after 20 years.

But qualifying for PAYE can be a hurdle for some borrowers. IBR, meanwhile, is easier to qualify for, and you may not need to consolidate any loans before applying.

Whether you choose IBR or Pay As You Earn, you’ll have to recertify your eligibility year after year. If your income goes up, your payments will rise, too. The silver lining is that your payments will never go higher than if you were on the Standard Repayment Plan.

Refinancing can also help lower your monthly payments

IBR and PAYE are not your only options for managing student loans. If you don’t meet the income requirements for these repayment plans, you could still lower your monthly payments with student loan refinancing.

Student loan refinancing is a good strategy for borrowers with a steady income and good credit score. When you refinance, you consolidate your student loans with a private lender. Depending on your credit history, you could also qualify for a lower interest rate and better terms. And if you’re looking to lower your monthly bills, you could choose a longer repayment term.

Keep in mind that if you extend your repayment plan, you may end up paying more interest over time. Luckily, once you start earning more money, you can pay more on your loan to get out of debt faster.

If you’re struggling to keep up with bills, getting on an income-driven repayment plan or refinancing your loans could be the solution you need. If IBR or Pay As You Earn sound like the right plan for you, learn how to apply for an income-driven repayment plan.

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